Task 1

We consider an individual facing the prices p1 and p2 on the two items x1 and x2. We

let m be the consumer's income.

a) Derive the individual's budget curve, and illustrate this in a diagram.

b) Illustrate in the diagram how an increase in the price of item 2, p2, will affect

the budget curve.

c) The individual has an income m = 24, and we let the prices of the two goods last p1 = 3 and

p2 = 3. The individual has preferences presented by the utility function:

U (x1, x2) = x1x2

What will be the individual's demand for the two goods, if we assume that

the individual acts as a benefit-maximizing consumer?

d) We look at a situation where the price of item 2 increases from p2 = 3 to p2 = 4, at the same time

as the price of item 1 decreases from p1 = 3 to p1 = 2. How will the new

the budget curve of the individual look like? Can the individual buy the old one

the good combination? In that case, it is optimal for the individual to buy it

old good combination? Will the individual prefer the old or the new

the prices? Justify the answer.